Expanding the benchmarks for pension funding status

Since using a single benchmark portfolio to measure a pension plan’s funding status paints a narrow picture, a new report by PBI Actuaries and Consultants looked at four different portfolio types to see how the equity fall off at the end of the year, among other market events, affected different asset mixes.

The liability portfolio kept its head up the best, landing at 99.6 per cent funded status on a going-concern basis at the end of 2018. Its construction consisted of 95 per cent long-duration bonds and five per cent equities. The next best, sitting at 95 per cent funded, was the portfolio with a liability-aware overlay using 40 per cent equities, 90 per cent bonds with a 30 per cent overlay.

The liability-aware benchmark, with a conservative 40 per cent equities and 60 per cent long-duration bonds balance, stood at 94.1 per cent funded. Meanwhile, the traditional 60 per cent equities, 40 per cent long-duration bonds portfolio was hit the hardest, posting a funded status of 91.1 per cent. During the first three quarters of 2018, all four indices showed far less volatility than in the final quarter, when all but the liability-driven benchmark took a sharp dip.

“We wanted to create a going-concern index that would allow pension plan trustees and committees to see how their funded ratio moves through time and the impact of different investment strategies and different markets,” says Bradley Hough, senior consultant at PBI.

Demonstrating the various outcomes is helpful when communicating with pension trustees, especially those that see more variation in their funded ratios than they’re comfortable with, says Hough. “It allows us to have that conversation to say, ‘Well, maybe it’s time to update your risk budget. And if you’re worried about these kinds of falls, which are part of the normal course of events, and you’re worried about extra contributions, have another look.’”

Expanding the data from the traditional 60/40 portfolio mix makes sense because that ratio is becoming less relevant in today’s defined benefit plan universe, says Hough.

However, as plans move more aggressively into alternative assets, that will be worth measuring as a benchmark option as well, he adds. “We’ve got a version with alternatives, to be released at a later date, that shows alternatives change the answer, and it depends on which alternatives you take and how you stretch them. We wanted to start off with something fairly simple and work from there.”

Hough adds quite a few pensions, particularly smaller and corporate plans, remain close to the 60/40 mix.

As more data becomes available, coinciding with the shift in asset mixes, it’s important to be able to see how different portfolios perform over time, in different market conditions, he says. “I think what we’re trying to do here is we’ve started off simply and we’ve set up something that’s fairly representative of the average pension plan. But we’ve tried to account for some variation.

“I think the next step would be to apply some technology and try and allow trustees to see a variety of different liability types and a variety of different pension plans. And we’re actually working on a tool that allows people, trustees and pension committees to do that. They can look at different liability types and different asset mixes and see that in real time.”

This article originally appeared on CIR’s companion site, Benefitscanada.com. Read the full story here.